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The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

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November 13, 2006


More Things Economists Don't Say

From The Weekly Standard (via Instapundit) comes an article by Harvard law professor William Stuntz, "explaining" how thinking like an economist is the wrong way to go about weighing the options in Iraq.  I hesitate to wade into these waters, as this blog is decidedly not about my opinions on anything but those related to my chosen profession -- and even then I try to keep the what-I-think factor low (in favor of the what-I-think-we-know approach).  But it seems to be the season of non-economists opining about what economics is all about, and I seem to be in the mood to object. 

So object I will.  But before I do, let me make this as clear: Nothing I'm about to say should construed as support, one way or another, for any particular position on whether the war was a good idea or bad idea, whether we should take this course or that course, or whatever.  I have opinions about such things, but if you are here for things I actually know about, there is no reason you should listen to them.  I am not interested Professor Stuntz's position on the war per se, but rather his characterization of what it means to think like an economist.

With that disclaimer, we begin:

When you gamble and lose, the natural tendency is to double your bet--and when that doesn't work, mortgage everything you have to try to retrieve your losses. But as every undergraduate economics student knows, that strategy is a disaster. Hence the principle of "sunk cost." The fact that I've lost a pile on some enterprise or investment is no reason to lose an even bigger pile. The smart move, economically speaking, is to reassess your decisions on a regular basis. When an investment isn't working, get out. Put your money, your talents, and your energy to better use somewhere else.

All of which seems to apply to Iraq, in spades. A seemingly quick and easy military victory has turned sour. The costs, in blood and treasure, have escalated. Victory looks uncertain and distant. It seems the time has come, if not to cut and run, then surely to cut our losses. If ever the principle of sunk cost applied to warfare, it would seem to apply here.

But that instinct is wrong. Warfare is not like investment banking. At precisely the moment an economist might say to stop throwing good money after bad, a wise military strategist might say to double the bet.

Why?

Why do insurgent gangs, who have vastly smaller resources and manpower than the American soldiers they fight, continue to try to kill those soldiers? The answer is, because they believe they only have to kill a few more, and the soldiers will leave. They need not inflict a military defeat (which would be impossible, given the strength of the American military)--all they need to do is survive until American voters decide to throw in the towel, which might happen at any moment.

All of which fits quite nicely into standard economist-like thinking.  What's on the table are the ideas of time inconsistency, commitment, and credibility, concepts that are these days the centerpieces of economic policy discussions.  Those ideas -- the germ of which was the basis for a recent Nobel prize -- go something like this:  Let's say that it is a good goal of monetary policy to deliver low and stable inflation, but that at any point in time the central bank can pump up the economy by delivering more inflation than people expect.  Though a central bank may have the best of intentions in announcing that it plans to deliver low inflation indefinitely, things will almost certainly look different when the economic going gets tough and a little monetary stimulus could help to pick things up a bit.  Everyone knows, of course, that these incentives exist -- that is, that the announced policy is time inconsistent -- and will refuse to believe that low inflation will delivered -- and refuse to be fooled.  Actual and expected inflation will therefore be higher than they would otherwise be, to no benefit.

There are two ways out of this dilemma  One is to adopt some sort of commitment device that will keep the central bankers on the straight and narrow -- a law, for example, that the monetary authorities will be removed from their positions if they renege on their low inflation promises.  Such devices are often hard to implement, so an alternative is for the policymaker to earn his or her credibility by consistently following through on plans.  This may be painful if that policymaker doesn't start with a lot of credibility, as it may require that monetary policy be especially tight in those times when the central bank is most expected to back off of its promise -- when the going gets tough.

Get the point?  The idea of "sunk costs" mentioned in the Stuntz article does in fact mean something like "look forward, don't look back."  But in policymaking, in economics as well as warfare, looking forward always means taking into account the fact that your credibility is at stake, and that the long-run costs may be very much higher if that credibility is lost.

Stuntz continues:

There is another reason economic logic does not readily apply to the fighting of wars. When running a business, one aims to invest just as much as is necessary to make the sale or manufacture the product--no less, and no more. Profit equals revenue minus cost, so minimizing cost lies at the core of wise business management.

Warfare could not be more different. Send just enough soldiers and guns and tanks to do the job, and you may soon find you have sent too few. The enemy concludes that if it can raise the marginal cost of the conflict just a bit, if casualties are a little higher or the expense a tad greater than you imagined, you'll quit the field.

Ah, but profit-maximizing does not mean minimizing cost.  There is a way to express profit-maximization in terms of cost minimization, but the condition is to minimize costs subject to a particular level of output.  If you send too few workers and too little capital to do the job, then what you are trying to do is not profit-maximizing -- it is infeasible.  Economics says no less.

In the world of business, decisions are made at the margin: a little more invested here, a bit less there; everywhere, strive to cut waste, to spend no more than is absolutely necessary. In warfare, waste and excess are productive: They send the message that victory is inevitable, that whatever resources are needed to obtain it will be given to the task.

It seems to me that productive "waste and excess" is not waste and excess.  Clearly Professor Stuntz is not suggesting that more soldiers and tanks be sent than necessary to ensure victory (at lowest long-run cost in blood and treasure).  So surely Professor Stuntz is not suggesting anything with which an economist would disagree -- at least not one obliged to accept his cost and benefit analysis.

In fact, the opinion expressed in the Weekly Standard article is just the well-known position that a favorable outcome in Iraq requires the application of greater levels of force than presently exist.  That is matter of great debate among military and political strategists.  For my part, I would just as soon we economists be left out of it.      

November 13, 2006 in This, That, and the Other | Permalink

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Comments

ABSOLUTELY WONDERFUL LINE I'll definitely borrow more than once: "I have opinions about such things, but if you are here for things I actually know about, there is no reason you should listen to them."

Posted by: bailey | November 13, 2006 at 08:42 PM

"I would just as soon we economists be left out of it."

Loyal economists don't "cut and run" with so much invested. Be strong!

Posted by: Alan Greenspend | November 13, 2006 at 10:59 PM

Have you written a letter to the editor? The issue here is that the Standard has allowed a writer with what is apparently very thin knowledge of what economists think to assert that he knows what economists think, and that they are wrong.

I agree that using economic logic alone is not all that wise in setting military strategy. Using "logic" of any kind alone is a mistake. What the author seems to be arguing, at least in part, is that economists use the wrong inputs. He doesn't know enough about that to publish his opinions, but we've already covered that point. Getting good answers from any discipline requires getting the right inputs. Economists do right well when they consult with colleagues from other disciplines about appropriate inputs.

Posted by: kharris | November 14, 2006 at 10:00 AM

My (non-economist) [actually I prefer 'recreational economist' and believe there is a surging market for this] heart warms to this:
"But it seems to be the season of non-economists opining about what economics is all about, and I seem to be in the mood to object."

Good on you, mate.

It's bad enough that The Economist has to import some lawyer (talk about a trade deficit!] to tell you what you should be writing about, but to actually print it, is beyond the pale.

At this point:
"I am not interested Professor Stuntz's position on the war per se, but rather his characterization of what it means to think like an economist.",
I'm going for a huge bag of popcorn because I know you're going to ask him where his Nobel Prize is for Lawyering just to be sure he has the right credential for being able to declare with authority his views on your and your colleagues' minds. (Was it a recent credential or has it lapsed? Could he have missed his period?)
Is this knock-out sarcasm or what?
"All of which fits quite nicely into standard economist-like (and so not much of a standard, but merely stardard-like or maybe even sub-standard or non-standard, possibly deviant) thinking." [The reference to an optimally chosen example of this troublesome (hell errant!) 'economist thinking', discarded with the same aplomb. You cannot be left behind when the tide of satire is running, can you? Can you?]

kharris, self-declared teacher and great respecter of the English language (not like some), and greatly respected writer of it too, writes with the usual earnestness (not like those same some):
"Economists do right well when they consult with colleagues from other disciplines about appropriate inputs."

And we don't know which is righter, the correction or the baiting. We don't.

Posted by: calmo | November 14, 2006 at 12:59 PM

It's real tough to have a serious discussion about anything if the participants have NO common objective and nothing at risk.
I, & I'm sure the rest of the American middle class, would LOVE for "the ideas of time inconsistency, commitment, and credibility" to be "the centerpieces of Economic discussion"! Let's start with the concepts of inflation & productivity measurements.
Remember the Boskin Hearings? AG front ran them with his proclamation that the CPI was at least a full point too high & that was the end of the Economic debate! Katharine Abraham (BLS Head) was widely respected, yet when she opined that it could equally be argued that the CPI was a point too low is it possible NO ONE asked her about this? Dropping the CPI a full point from already low readings has had a MONUMENTAL impact on FED monetary policy & our economy. Where was the Economic debate?
M3 may not have been a "perfect" money supply indicator but for many years it was considered the closest measurement we had (since we accepted Mr. Friedman's thesis that "inflation is always and everywhere a monetary phenomenon." Just when did WE toss Mr. Friedman's theory aside & what did we replace it with?

Posted by: bailey | November 14, 2006 at 06:12 PM

Perhaps the politicizing of science is the culprit. The "dismal science" is certainly an easy target, due to it's extraordinary complexity on the whole and difficulty of being reduced to accurate soundbites.

For the last number of years it's been a war on unprofitable science in general, whether politically or economically unprofitable. "Deficits don't matter", right?

Whenever your field/passion or good name is threatened wrongfully, it's always best to fight with all your strength.

Posted by: Alan Greenspend | November 15, 2006 at 01:01 AM

and in today's WSJ an article that talks about how a scientist has debunked Hayek's theory on free markets.

economists are under a frontal assault.

adam smith works just as well as darwin. perhaps darwin is should be renamed the economics of the species.

Posted by: jeff | November 15, 2006 at 08:07 AM

Simple three-fold question: how much does it cost to deliver a raytheon missile to its target in Iraq, what's the value of the reconstruction contract on the building it destroys, and who pays the redevelopment loans?

You know. Creative destruction.

"Early in 1942, annual estimates of gross national product were introduced to complement the estimates of national income and to facilitate war time planning. Wartime planning needs also helped to stimulate the development of input-output accounts. Nobel laureate Wassily Leontief developed the U.S. input-output accounts that subsequently became an integral part of the NIPA's. In commenting on the usefulness of the national accounts, Wesley C. Mitchell, Director, National Bureau of Economic Research, said: "Only those who had a personal share in the economic mobilization for World War I could realize in how many ways and how much estimates of national income covering 20 years and classified in several ways facilitated the World War II effort."

http://bea.gov/bea/aw/0100od/maintext.htm

Posted by: Aaron | November 16, 2006 at 04:43 PM

Of course the article is a silly strawman destruction and shows more flaws in the author then it does in those he targets.

Moving on to actually considering the subject...I think more and more people on the right and on the left are coming ready to consider abandoning a sunk cost in Iraq and letting the place sort itself out.

Similarly, economics does not say that one only puts the minimum possible expenditure for an eventuality. Lots of companies spend money on insurance or pay for maintenance departments. The decision to do so is rational. If they knew they could cut it they would. But they don't know. So paying for an excess over the minimum risk is rational. It takes into consideration the overall risk picture. Of course the writer is likely too butt-stupid to have this intuition.

An interesting side-note was Heinlein (or was it Pournelle or Freidman?) who said when asked about the expensive military...expressed the opinion that what was really expensive was being on the losing end of a war.

Posted by: TCO | November 18, 2006 at 05:43 PM

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